SEP 401k vs SEP IRA – Which is the Better One for You?

Both the SEP IRA and the SEP 401k are retirement plans for small businesses, and the one that you choose will depend on certain conditions and preferences of the business owner, which , if you are reading this is probably you.

They each have different benefits and drawbacks and they each are appropriate for different objectives. However, if you do not understand those differences, it will be difficult to choose the right one for your needs.

A SEP IRA allows employees to contribute up to 25 percent of their compensation, up to $53,000 each year. The contributions are made pre-tax, which means the participants do not have to pay taxes on their funds until they withdraw them from their account. This type of retirement account is exactly like any other traditional IRA, but specifically designed for small businesses. This means employers are authorized to take out contributions from paychecks automatically with the employees’ permission.

A SEP 401k plan allows employees to contribute up to $18,000 for 2016 on a pre-tax basis. In addition to the employee contributions, though, employers are also able to contribute up to 25 percent of the employee’s total annual compensation in matching funds. The maximum amount the employer can contribute for 2016 is $53,000. This means employees who have a SEP 401k plan can save a whole lot more money for their retirement than employees with SEP IRA plans can. Still, there are some restrictions that apply to individual 401k plans that can make them less attractive.

When to Choose a SEP 401k Plan:

There is one qualification that will determine whether or not your small business is even eligible for a 401k plan.

You cannot have any full time employees other than yourself and your spouse. This is why many small companies will go with a SEP IRA over a SEP 401k. They simply don’t qualify for it. So, if you meet this requirement, then you can look at the other differences between an IRA and a 401k plan to determine which plan you should choose.

If you are looking to put a lot of money away for your retirement, the 401k plan is the way to go, especially if you earn less than $200,000 per year.

Here’s an example of how much you could save each year with a solo 401k. If your business earns $100,000 after expenses, you can put away $18,000 per year as an employee. Then, as the employer, you can put away 25 percent of that $100,000, which equals $25,000. This gives you a grand total of $43,000 per year for your retirement.

In addition, the limits will likely keep rising over the years, allowing you to put away even more. Keep in mind, though, if you have more than one 401k account, the maximums apply for the total amount you contribute to all of them.

With a SEP IRA, as an employee, you can only contribute a maximum of $5,500 per year. As an employer, you can still contribute 25 percent of employee income each year. So, if you earn $100,000, you are able to save $30,500 per year instead of the $42,500. You will leave $12,000 on the table every year. By the time you retire, this can really add up.

When to Choose a SEP IRA:

Clearly, if your small business doesn’t qualify for a SEP 401k, then you should go with a SEP IRA as it’s one of your only retirement plan choices.

If you have full time employees other than yourself and your spouse, giving them the opportunity to contribute to a retirement fund is an excellent way to build employee loyalty while helping them plan for life after employment at the same time.

Regardless of which plan you choose for your small business, it is important to choose one of them. After all, you, and any employees you may have, need a way to save for retirement. This is particularly important for you if you are an independent consultant or contractor. Use this calculator to determine how much you are going to need to retire to help you make your decision on which plan to choose. Do it quickly, as you don’t have a pension available to you from an employer, so you need to take care of your future yourself.

You Can Start Your Own Business:

The good news about business income is that you can earn it even if you’re already employed. You just need to start offering services on the side, and then keeping track of your business transactions for your annual tax filing.

If you’d like to go bigger, you can always apply for a loan and really take your business to the next level. Lots of people have started successful businesses employing no more than a small group of people. With the accessibility of the Internet, lots of small businesses have drastically cut down their overhead expenses, which then helps to keep the business thriving. That just leaves more money to put in your retirement plan!

IRA vs 401k Central is for entertainment and reference purposes only. The information presented is the opinion of the author only and should not be interpreted as specific advice or recommendations towards your financial situation. Always consult with a true professional before making any financial decisions.

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